Inland Development Co. v. Commissioner of Int. Rev.

• Decision Date: 09 June 1941
• Docket Number: No. 2210.,2210.
• Citation: 120 F.2d 986
• Parties: INLAND DEVELOPMENT CO. v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Tenth Circuit

120 F.2d 986 (1941)

INLAND DEVELOPMENT CO. v. COMMISSIONER OF INTERNAL REVENUE.

No. 2210.

Circuit Court of Appeals, Tenth Circuit.

June 9, 1941.

Roy C. Lytle, of Oklahoma City, Okl., for petitioner.

Louise Foster, Sp. Asst. to Atty. Gen. (Samuel O. Clark, Jr., Asst. Atty. Gen., and Sewall Key and Newton K. Fox, Sp. Asst. to Atty. Gen., on the brief), for respondent.

Before PHILLIPS, BRATTON, and MURRAH, Circuit Judges.

BRATTON, Circuit Judge.

The determinative question presented on this petition to review a decision of the Board of Tax Appeals is whether Inland Development Company, hereinafter called the taxpayer, was a personal holding company and therefore liable for surtax for the year 1934 under section 351 of the Revenue Act of 1934, 48 Stat. 680, 751, 26 U.S. C.A. Int.Rev.Acts, page 757. The Commissioner of Internal Revenue found that the taxpayer was such a company, and a resulting deficiency in surtax followed; the Board sustained that action; and the taxpayer seeks review.

The cause was submitted to the Board on these stipulated facts. Robert A. Wallace owned various oil and gas leases in Oklahoma, but he lacked sufficient capital for development and in consequence was in danger of losing them. On September 9, 1932, Wallace and George W. Robinson, as trustee, entered into a certain written contract in which it was agreed that Wallace should transfer to Robinson, as trustee, certain leases and overriding royalties; that the trustee should cause the taxpayer to be incorporated, and should then transfer and assign such leases and royalties to it; and that in consideration therefor the corporation should issue 30,000 shares of its common stock to Wallace or his nominee. The contract was subsequently amended to reduce the stock ownership of Wallace and to change other provisions not material here. On September 12, the taxpayer was incorporated under the laws of Delaware, and was subsequently authorized to engage in business in Oklahoma; and it issued common stock of the value of $150,000 for which it received $135,000 in cash, and leases, royalties and other property valued at $15,000. Pending consummation of the entire transaction, Wallace conveyed the leases and overriding royalties to the trustee. At the request of the taxpayer, the trustee assigned one of the leases to Alpha Oil Company, one to Corsican Oil Company, and one to Wisconsin Oil Company, all being corporations organized under the laws of Oklahoma; and he transferred all of the remaining leases and royalties to the taxpayer. Alpha Oil Company, Corsican Oil Company, and Wisconsin Oil Company issued and delivered to the taxpayer their entire authorized capital stock in consideration for the leases respectively transferred to them, and at all times thereafter during the existence of such corporations the taxpayer owned their entire capital stock. Each subsidiary owned the lease transferred to it in that manner but it had no other assets of any kind. A well was drilled for each subsidiary under a contract executed by the subsidiary, but all obligations incurred in drilling and operating the wells were paid by the taxpayer. As the taxpayer paid the indebtedness of each subsidiary, it charged the subsidiary's account on the books of the taxpayer with the amount. The income from the sale of oil produced from the wells was received by the taxpayer in accordance with division orders signed by the respective subsidiaries, was credited to the account of the particular subsidiary on the books of the taxpayer, and was deposited in the bank to the account of the taxpayer. All sums borrowed for operating expenses were borrowed by the taxpayer, except in one instance in which the property of one subsidiary was mortgaged to secure payment of certain obligations of the taxpayer. All employees were engaged and paid by the taxpayer. Both direct and indirect labor bills were allocated to the subsidiary companies on the books of the taxpayer on the basis of the time spent on the respective leasehold estates. None of the subsidiaries had a bank account, and none ever paid salaries to employees. During the years 1933 and 1934, the taxpayer transferred one of its undeveloped leases to Timken Oil Company, a corporation organized under the laws of Oklahoma, and took as consideration for it all of the authorized and issued capital stock of that company. A well was drilled for the Timken Company under a contract executed by it, and such leasehold was operated in the same manner as those of the other subsidiary companies. The taxpayer likewise transferred one of its leases to Franco Oil Company, a corporation organized under the laws of Oklahoma, and received in exchange for it all of the authorized capital stock of that company. A well was drilled for the Franco Company under a contract executed by it. That well was operated in the same manner as the wells upon leases of the other subsidiary companies; but it never returned its investment and the lease was subsequently released to the lessor. During 1934, the Victor Oil Company, likewise a wholly owned subsidiary of the taxpayer, acquired certain leases. The taxpayer paid for them and charged the amount on its books against the account of the subsidiary. On December 31, 1933, the books of the taxpayer contained an account receivable from subsidiaries of $168,053.03; on December 31, 1934, of $168,157.88; and on December 31, 1935, of $223,307.33.

At a meeting of the directors of Alpha Oil Company, held June 15, 1934, it was resolved that a dividend of $4.25 per share be declared on the stock of the company, payable on July 1st. On December 31, an entry was made on the books of the subsidiary charging the earned surplus account with $53,125 and crediting the account of the taxpayer with that amount; on the same day an entry was made on the books of the taxpayer charging the account of the subsidiary and crediting dividends received with the same amount; and the taxpayer paid to its stockholders in dividends out of such amount the sum of $30,000, part of the remaining sum was used for expenses of the taxpayer, and the balance was added to its surplus.

The gross income of the taxpayer during the year 1934 was $63,288.22, of which slightly more than $9,000 was interest received, $900 plus was miscellaneous income, and $53,125 represented the funds referred to in the resolution of the Board of Directors of Alpha Oil Company. More than fifty per cent in value of the stock of the taxpayer was owned by five or less persons.

Section 351, supra, levied a surtax upon every personal holding company equal to thirty per cent of its undistributed net income up to $100,000, plus forty per cent of the amount thereof in excess of that sum; and it defined the term "personal holding company." The material part of the definition reads: "The term `personal holding company' means any corporation (other than a corporation exempt from taxation under section 101, and other than a bank or trust company incorporated under the laws of the United States or of any State or Territory, a substantial part of whose business is the receipt of deposits, and other than a life-insurance company or surety company) if — (A) at least 80 per centum of its gross income for the taxable year is derived from royalties, dividends, interest, annuities, and (except in the case of regular dealers in stock or securities) gains from the sale of stock or securities, and (B) at any time during the last half of the taxable year more than 50 per centum in value of its outstanding stock is owned, directly or indirectly, by or for not more than five individuals."

Section 115(a), 26 U.S.C.A. Int.Rev.Acts, page 703, defined the term "dividend" to mean any distribution made by a corporation to its shareholders, in money or other property, out of earnings or profits accumulated since February 28, 1913.

The legislative purpose of section 351 was to end a long practiced method of tax avoidance. That method was for an individual to form a corporation, take its entire capital stock in exchange for his personal holdings in stock, bonds, or other income-producing property, and in that manner subject the income to corporation tax but avoid...